AP6B: Step acquisition - IFRS Foundation

The IFRS Interpretations Committee is the interpretative body of the International Accounting Standards Board (Board). The Board is the independent standard-setting body of the IFRS Foundation, a not-for-profit corporation promoting the adoption of IFRS Standards. For more information, visit www.ifrs.org.

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STAFF PAPER September 2018

IFRS® Interpretations Committee meeting

Project IAS 27 Separate Financial Statements––Investment in a subsidiary accounted for at cost: Step acquisition

Paper topic Initial consideration CONTACT(S) Vincent Louis [email protected] +44 (0) 20 7246 6470

Jawaid Dossani [email protected] +44 (0)20 7332 2742

This paper has been prepared for discussion at a public meeting of the IFRS Interpretations Committee (Committee) and does not represent the views of the International Accounting Standards Board (Board), the Committee or any individual member of the Board or the Committee. Comments on the application of IFRS® Standards do not purport to set out acceptable or unacceptable application of IFRS Standards. Decisions by the Board are made in public and reported in IASB® Update. Decisions by the Committee are made in public and reported in IFRIC® Update.

Introduction

1. The IFRS Interpretations Committee (Committee) received a submission about the

application of IAS 27 Separate Financial Statements when an entity obtains control of

another entity in which it previously held an interest.

2. The objective of this paper is to:

(a) provide the Committee with a summary of the matter and our research and

analysis; and

(b) ask the Committee whether it agrees with our recommendation not to add

the matter to its standard-setting agenda.

Structure of the paper

3. This paper includes:

(a) background information;

(b) summary of outreach;

(c) staff analysis;

(d) staff recommendation; and

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IAS 27––Step acquisition transaction│Initial consideration

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(e) questions for the Committee.

4. There are two appendices to this paper:

(a) Appendix A—proposed wording of the tentative agenda decision; and

(b) Appendix B—submission.

Background information

5. Paragraph 10 of IAS 27 requires an entity that prepares separate financial statements

to account for investments in subsidiaries, joint ventures and associates either:

(a) at cost;

(b) in accordance with IFRS 9 Financial Instruments; or

(c) using the equity method as described in IAS 28 Investments in Associates

and Joint Ventures.

6. In the fact pattern described in the submission, Entity X:

(a) prepares separate financial statements applying IAS 27;

(b) holds an equity interest in Entity Y (initial interest). This initial interest

does not give Entity X control or joint control of, or significant influence

over, Entity Y. The initial interest is an equity instrument as defined in

paragraph 11 of IAS 32 Financial Instruments: Presentation. Entity X

applies IFRS 9 in accounting for its initial interest and measures it at fair

value1.

(c) subsequently acquires an additional equity interest in Entity Y (additional

interest). The acquisition of this additional interest results in Entity X

obtaining control of Entity Y––ie Entity Y becomes a subsidiary of

Entity X (step acquisition transaction). Applying paragraph 10 of IAS 27,

Entity X elects to measure its investment in Entity Y at cost.

1 See paragraphs 18–19 of Agenda Paper 6A for this meeting for a discussion about the requirements in IFRS 9 on accounting for investments in equity instruments.

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7. The submitter asks how Entity X determines the cost of its investment in Entity Y on

the date it obtains control of Entity Y (Question A). In particular, the submitter asks

whether the cost of the investment in Entity Y is the sum of:

(a) the fair value of the initial interest on the date Entity X obtains control of

Entity Y, plus the consideration paid for the additional interest (FV as

deemed cost approach).

(b) the consideration paid for the initial interest when Entity X acquired the

initial interest (original consideration), plus the consideration paid for the

additional interest (accumulated cost approach).

8. To illustrate this fact pattern, the submitter provided the following numerical

example:

(a) Entity X holds a 10 per cent equity interest in Entity Y, which it originally

acquired for CU2100.

(b) Entity X subsequently acquires an additional 45 per cent interest in Entity Y

and obtains control of Entity Y. Entity X pays CU540 for this additional

interest.

(c) on the date Entity X obtains control of Entity Y, the fair value of the initial

10 per cent interest in Entity Y is CU120.

9. Applying the two approaches set out in paragraph 7 of this paper, Entity X would

determine the cost of its investment in Entity Y on the date it obtains control of

Entity Y as follows:

2 In this paper, monetary amounts are denominated in ‘currency units’ (CU).

(amounts in CU) FV as deemed cost

Accumulated cost

Consideration paid for the 10% initial interest 100

Fair value of the 10% initial interest 120

Consideration paid for the 45% additional interest 540 540

Cost of the investment in Entity Y (55% interest) 660 640

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10. If an entity applies the accumulated cost approach, the submitter asks how Entity X

accounts for any difference between (i) the fair value of its 10% initial interest on the

date it obtains control of Entity Y (ie CU120) and (ii) the original consideration

(CU100) (Question B). The submitter also asks whether the conclusion would differ

depending on whether Entity X, before obtaining control of Entity Y, measures its

initial interest:

(a) at fair value through profit or loss (FVPL); or

(b) at fair value and applies the presentation election in paragraph 4.1.4 of

IFRS 9 to present in OCI subsequent changes in fair value of the initial

interest.

11. The submitter’s questions relate only to separate financial statements and not to

consolidated financial statements. Appendix B to this paper reproduces the

submission and provides further details about the accounting approaches identified by

the submitter.

Summary of outreach

12. We sent information requests to members of the International Forum of Accounting

Standard-Setters, securities regulators and the large accounting firms.

13. In our request we asked whether, in the participants’ experience, the step acquisition

transaction is common.

14. In addition, if the step acquisition transaction were common we asked:

(a) whether entities that, applying paragraph 10 of IAS 27, elect to account for

investments in subsidiaries at cost, apply the FV as deemed cost approach

or the accumulated cost approach (see paragraphs 7–9 of this paper) to

determine the cost of their investment in the subsidiary;

(b) whether entities, before obtaining control, elect to present in OCI

subsequent changes in fair value of the initial interest; and

(c) if applying the accumulated cost approach, how entities recognise any

difference between (i) the fair value of the initial interest on the date of

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obtaining control of the investee and (ii) the consideration paid for this

initial interest.

15. We received thirteen responses—five from the large accounting firms, four from

national standard-setters, two from regulators, one from an organisation representing

groups of regulators and one from a Committee member. The views received

represent informal opinions and do not represent the official views of those

respondents.

Findings

Prevalence of transactions

16. Respondents indicated that the prevalence of the step acquisition transaction depends

on whether entities:

(a) are required or permitted to prepare separate financial statements;

(b) apply IFRS Standards in preparing those separate financial statements; and

(c) elect or are required (because of jurisdictional regulations) to measure

investments in subsidiaries at cost in those separate financial statements.

17. Four respondents said they had no experience of this transaction and two respondents

said their experience is limited. This is because entities in their jurisdictions are either

not required to prepare separate financial statements or do not apply IFRS Standards

to separate financial statements.

18. Seven respondents said the step acquisition transaction occurred more than

infrequently in some jurisdictions.

Determining the ‘cost’ of the investment in the subsidiary

19. Five respondents said both the FV as deemed cost approach and the accumulated cost

approach are applied in practice. One respondent said the FV as deemed cost

approach is predominant in its jurisdiction while another said the accumulated cost

approach is predominant. In addition, one respondent with limited experience of

those transactions said the accumulated cost approach is more common.

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Presenting subsequent changes in fair value of the initial interest

20. Because IFRS 9 is effective for annual reporting periods beginning on or after

1 January 2018, respondents had not observed whether entities, before obtaining

control, elect to present in OCI subsequent changes in fair value of the initial interest.

However, respondents said entities applying IAS 39 Financial Instruments:

Recognition and Measurement generally classified the initial interest as an available-

for-sale equity instrument (AFS)3.

Accounting for any difference between the fair value and consideration paid

for the initial interest

21. Two respondents said entities predominantly present any difference directly in equity:

(a) One respondent said entities present the difference directly in equity but did

not specify which component of equity.

(b) The other respondent said an entity presents the difference in retained

earnings if the entity had measured the initial interest at FVPL, or in

accumulated OCI if the entity had presented in OCI any subsequent

changes in fair value.

22. Two respondents said entities recognise any difference in profit or loss if the entity

had measured the initial interest at FVPL. If the entity had presented subsequent

changes in fair value in OCI, the entity recognises any difference in OCI.

Staff analysis

Question A: How does an entity determine the cost of an investment acquired in stages?

What is cost?

23. IAS 27 does not define ‘cost’. It also does not explicitly specify how to determine the

cost of an investment acquired in stages.

3 The requirements in IAS 39 for accounting for equity instruments classified as AFS differ from the requirements in IFRS 9 for equity instruments for which an entity elects to present in OCI subsequent changes in fair value.

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24. Nonetheless, paragraph 6 of IAS 16 Property Plant and Equipment, paragraph 8 of

IAS 38 Intangible Assets and paragraph 5 of IAS 40 Investment Property include a

definition of the cost of an asset (emphasis added):

Cost is the amount of cash or cash equivalents paid or the fair

value of the other consideration given to acquire an asset at the

time of its acquisition or construction or, where applicable, the

amount attributed to that asset when initially recognised in

accordance with the specific requirements of other IFRSs, eg

IFRS 2 Share-based Payment.

25. Similarly, the 2018 Conceptual Framework for Financial Reporting (Conceptual

Framework) discusses different measurement bases. Paragraph 6.5 of the Conceptual

Framework states:

The historical cost of an asset when it is acquired or created is

the value of the costs incurred in acquiring or creating the asset,

comprising the consideration paid to acquire or create the asset

plus transaction costs…

26. Paragraph 10 of IAS 28 Investments in Associates and Joint Ventures requires an

entity to initially recognise its investment in an associate or joint venture at cost.

Similar to IAS 27, IAS 28 does not define cost. In May 2009, the Committee

discussed how an entity determines the cost of its investment in an associate. The

agenda decision issued in July 2009 states (emphasis added):

…Generally stated, cost includes the purchase price and other

costs directly attributable to the acquisition or issuance of the

asset such as professional fees for legal services, transfer taxes

and other transaction costs. Therefore, the cost of an

investment in an associate at initial recognition determined in

accordance with paragraph 10 of IAS 28 comprises its purchase

price and any directly attributable expenditures necessary to

obtain it…

27. We think that even though IAS 27 does not define cost, an entity can apply the

principles and requirements outlined in paragraphs 24–26 of this paper to determine

the cost of an investment in a subsidiary when applying IAS 27.

https://www.ifrs.org/-/media/feature/supporting-implementation/agenda-decisions/ias-28ifrs-3ias-27-july-2009.pdf

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Cost in a step acquisition transaction

28. From the date it obtains control, Entity X stops applying IFRS 9 in accounting for its

investment in Entity Y and instead elects to account for it at cost applying paragraph

10 of IAS 27. As mentioned above, IAS 27 does not explicitly specify how to

determine the cost of an investment acquired in stages.

29. We think the different approaches outlined in paragraph 7 of this paper arise from

different views about whether the step acquisition transaction involves:

(a) Entity X exchanging its initial interest (plus consideration paid for the

additional interest) for a controlling interest in Entity Y (exchange view); or

(b) Entity X purchasing the additional interest while retaining the initial interest

(non-exchange view).

30. If Entity X applies the exchange view, then in applying the principles and

requirements discussed in paragraphs 24–26 of this paper, it would include the fair

value of the initial interest on the date Entity X obtains control of Entity Y as part of

the purchase price or consideration given to acquire the controlling interest. Using

this view, Entity X would apply the FV as deemed cost approach to measure its

investment in Entity Y at the date of the step acquisition transaction, and the cost of

its investment in Entity Y (55% interest) would be CU660.

31. Instead if Entity X applies the non-exchange view, then it would not include the fair

value of the initial interest in the purchase price or consideration given to acquire the

controlling interest. Accordingly, using this view, Entity X would apply the

accumulated cost approach to measure its investment in the subsidiary and the cost of

the investment in Entity Y (55% interest) would be CU640.

32. In determining which of these two views Entity X applies, we considered the

requirements in paragraphs 10–11 of IAS 8 Accounting Policies, Changes in

Accounting Estimates and Errors (which apply when IFRS Standards do not

specifically apply to a transaction). We first considered if there are requirements in

IFRS Standards dealing with similar and related issues. We identified two

transactions or events for which an entity (i) stops applying IFRS 9 to an investment

in another entity and (ii) starts applying another measurement basis. In both these

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cases, an entity is required to determine the consideration paid at the date of the

transaction or event.

33. Paragraph 42 of IFRS 3 Business Combinations contains requirements for a business

combination achieved in stages. It states:

In a business combination achieved in stages, the acquirer shall

remeasure its previously held equity interest in the acquiree at

its acquisition-date fair value and recognise the resulting gain or

loss, if any, in profit or loss or other comprehensive income, as

appropriate...

34. Paragraph BC384 of IFRS 3 explains that the Board views a business combination

achieved in stages as a transaction in which an acquirer exchanges its status as an

owner of a non-controlling interest in a business for a controlling interest in all of the

underlying assets and liabilities of that business. The Board concluded that such a

transaction is a significant change in the nature of, and economic circumstances

surrounding, that investment. That change warrants a change in the classification and

measurement of that investment.

35. Paragraph 11B(a) of IAS 27 contains requirements on how an entity accounts for an

investment in a subsidiary when it ceases to be an investment entity. In this situation,

the entity ceases to measure its investment in the subsidiary at fair value applying

IFRS 9 and, instead, applies IAS 27 to the investment from the date it ceases to be an

investment entity. The paragraph states:

…when an entity ceases to be an investment entity, the entity

shall account for an investment in a subsidiary in accordance

with paragraph 10. The date of the change of status shall be the

deemed acquisition date. The fair value of the subsidiary at the

deemed acquisition date shall represent the transferred deemed

consideration when accounting for the investment in

accordance with paragraph 10.

36. While the Basis for Conclusions to IAS 27 does not explain the basis for these

requirements, IFRS 10 contains similar requirements for an entity that ceases to be an

investment entity. Paragraph BC271 of IFRS 10 explains the rationale for the

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requirements and states that ‘…This treats the change in business purpose of the

investor as a significant economic event…’.

37. In both these situations, the Board concluded that there is a significant economic

event. Similarly, we think the step acquisition transaction is a significant economic

event—this is because Entity X obtains control of Entity Y. In addition, IAS 27

contains different measurement requirements for controlling interests in an entity than

for non-controlling interests that do not give rise to joint control or significant

influence.

38. In both these situations, the fair value—and not the original cost—of the investment

in the other entity is deemed to be the consideration paid at the date of the transaction

or event.

39. Similarly, paragraph 60 of IAS 40 requires that when an entity transfers an investment

property carried at fair value to owner-occupied property or inventories, the property’s

deemed cost for subsequent accounting applying IAS 16, IFRS 16 Leases or IAS 2

Inventories is its fair value at the date of change in use.

40. Based on these requirements, we think in the step acquisition transaction, the cost of

Entity X’s investment in Entity Y includes the fair value of the initial interest at the

date Entity X obtains control, and not its original cost (ie FV as deemed cost

approach).

41. Applying this approach, the consideration given is (a) the purchase price of the

additional interest and (b) the fair value of the initial interest at the date Entity X

obtains control. In other words, when Entity X obtains control of Entity Y, it

exchanges its status as an owner of a non-controlling interest (plus consideration paid

for the additional interest) for an investment that gives Entity X control of Entity Y.

42. For illustrative purposes, we consider the numerical example set out in paragraph 8 of

this paper. Applying the FV as deemed cost approach, Entity X would derecognise

the initial interest and instead recognise the total investment in Entity Y at the date of

the step acquisition transaction.

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43. When Entity X acquires the initial interest, it recognises the initial interest as follows:

(Dr) Investment in Entity Y 100

(Cr) Cash or Payable 100

44. The entity recognises changes in fair value of its initial interest as follows:

(Dr) Investment in Entity Y 20

(Cr) Fair value increase4 20

45. At the date Entity X obtains control of Entity Y, it records the following to recognise

the step acquisition transaction:

(Dr) Investment in Entity Y (subsidiary) 660

(Cr) Investment in Entity Y 120


46. This journal entry results in the cost of Entity X’s investment in Entity Y being

CU660 (ie CU120 fair value of the initial interest + CU540 consideration paid for the

additional interest).

Is there an alternative way to read the requirements?

47. Notwithstanding our view that Entity X applies the FV as deemed cost approach in

accounting for the step acquisition transaction, we considered whether the

requirements could be read to support applying the accumulated cost approach. As

mentioned in paragraph 29 of this paper, Entity X might consider that the step

acquisition transaction simply involves acquiring an additional interest in Entity Y

while retaining the initial interest.

48. In July 2010, the Committee considered a similar transaction. As discussed in

paragraph 26 of this paper, paragraph 10 of IAS 28 requires an entity to initially

recognise its investment in an associate or joint venture at cost. The Committee

considered a transaction in which an entity acquires an investment in an associate in

4 Entity X would present this increase in profit or loss unless, applying paragraph 4.1.4 of IFRS 9, it elects to present in OCI subsequent changes in fair value of its initial interest.

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stages and had classified its initial interest as AFS5 until the investment became an

associate. The Committee discussed the amount at which the entity measures its

investment in the associate at the date it obtains significant influence. Because of the

acknowledged diversity in practice, the Committee recommended that the matter be

referred to the Board for consideration (see July 2010 IFRIC Update—IAS 28 —

Purchases in stages—fair value as deemed cost). In September 2011, the Board

decided not to include this matter in its Annual Improvements process (September

2011 IASB Update). The Board has not further discussed the matter.

49. Although July 2010 IFRIC Update does not discuss the different approaches applied

in practice, we understand from the relevant staff paper that the two methods applied

in practice to account for this transaction were similar to the two approaches described

in paragraph 7 of this paper.

50. In addition, the requirements for similar and related transactions that make reference

to the cost of, or consideration for, the related transaction (see paragraphs 35 and 39

of this paper) specially refer to the fair value being used as the ‘deemed’ cost of, or

the ‘deemed’ consideration for, the related transaction. The concept of ‘deemed cost’

is also used in IFRS 1 First-time Adoption of International Financial Reporting

Standards. Appendix A of IFRS 1 defines deemed cost as (emphasis added) ‘an

amount used as a surrogate for cost or depreciated cost at a given date…’.

51. We also note that the definition of ‘historical cost’ in the Conceptual Framework

(reproduced in paragraph 25 of this paper) and the May 2009 Committee’s agenda

decision (reproduced in paragraph 26 of this paper) both focus on the ‘purchase price’

or ‘consideration paid’. Some might say the purchase price or consideration paid can

refer only to the consideration that was originally paid for the initial interest.

52. Applying this view, Entity X determines the cost of its investment in Entity Y as the

consideration paid for the initial interest when Entity X acquired that initial interest,

plus the consideration paid for the additional interest. In effect, this approach

accumulates the costs of earlier purchases of interests in the investee. This approach

5 The entity applied IAS 39 in accounting for its initial interest before obtaining significant influence.

http://archive.ifrs.org/Updates/IFRIC-Updates/2010/Documents/IFRICUpdateJUL10.pdf

http://archive.ifrs.org/Updates/IFRIC-Updates/2010/Documents/IFRICUpdateJUL10.pdf

http://archive.ifrs.org/Updates/IASB-Updates/2011/Documents/IASBupdateSept2011.pdf

http://archive.ifrs.org/Updates/IASB-Updates/2011/Documents/IASBupdateSept2011.pdf

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(accumulated cost approach) considers each acquisition of an interest in Entity Y to be

a separate transaction.

53. For illustrative purposes, we consider the numerical example set out in paragraph 8 of

this paper. Applying the accumulated cost approach, Entity X would record the

following at the date of the step acquisition transaction6:

(a) Entity X recognises the purchase of the additional interest as follows:

(Dr) Investment in equity instrument 540


(b) Because the cost of Entity X’s investment in Entity Y is determined on the

basis of the cost of each interest purchased, the entity must reverse any

difference between (i) the fair value of the initial interest on the date the

entity obtains control of the investee (ie CU120) and (ii) the consideration

paid for this interest (ie CU100). Entity X recognises this adjustment as

follows:

(Dr) Adjustment to the cost of equity instrument7 20

(Cr) Investment in equity instrument 20

These journal entries result in the total cost of the investment being CU640 (ie CU100

consideration paid for the initial interest + CU540 consideration paid for the

additional interest).

54. The accumulated cost approach results in Entity X adjusting the measurement basis of

the initial interest––ie the entity ‘resets’ the value of the initial interest from fair value

to its original cost and in effect unwinds previously recognised fair value changes. No

similar adjustment is needed when applying the FV as deemed cost approach because

the fair value of the initial interest, on the date the entity obtains control of Entity Y, is

included as part of the cost of the total investment in Entity Y.

6 Before the step acquisition transaction, Entity X would record the acquisition of the initial interest and changes in fair value of the initial interest in same manner as described in paragraphs 43–44 of this paper. 7 We discuss later in this paper (see Question B) how Entity X accounts for this adjustment.

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55. Based on the existing requirements in IFRS Standards and our consideration of

similar and related matters, we think Entity X could interpret the requirements to

support the application of the accumulated cost approach.

Summary

56. Based on our analysis of the applicable requirements, we think Entity X applies the

FV value as deemed cost approach to account for the step acquisition transaction.

Nonetheless, based on existing requirements in IFRS Standards and our consideration

of similar and related matters, we think Entity X could interpret the requirements to

support applying the accumulated cost approach.

Question 1 for the Committee

Does the Committee agree with our analysis set out in paragraphs 23–56 of

this paper that, based on existing requirements in IFRS Standards, an entity

could apply either the FV as deemed cost approach or the accumulated cost

approach in accounting for the step acquisition transaction?

Question B: accounting for any difference between the fair value of the initial interest and its original cost (accumulated cost approach)

57. Before the step acquisition transaction, Entity X applies IFRS 9 in accounting for the

initial interest. Applying paragraph 4.1.4 of IFRS 9, Entity X presents subsequent

changes in fair value of that initial interest in either profit or loss or OCI.

58. If, at initial recognition, the entity elects to present subsequent changes in fair value in

OCI, applying the requirements in paragraph B5.7.1 of IFRS 9 the entity:

(a) does not subsequently transfer to profit or loss the amounts presented in

OCI (ie recycling is prohibited).

(b) may transfer the cumulative gain or loss within equity. As explained in

paragraph BC5.26 of IFRS 9, the Board did not provide specific

requirements related to that transfer because of the existence of jurisdiction-

specific restrictions on components of equity. Accordingly, an entity may

transfer the cumulative gain or loss within equity at any time but is not

required to do so.

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59. As discussed in paragraph 54 of this paper, if Entity X applies the accumulated cost

approach to account for the step acquisition transaction, it must recognise any

difference between the fair value of the initial interest at the date of obtaining control

(CU120 in paragraph 53(b) of this paper) and the original consideration paid for that

initial interest (CU100 in paragraph 53(b) of this paper). In this section, we consider

how Entity X accounts for this difference.

60. Any difference results from a change in the measurement basis of Entity X’s initial

interest in Entity Y because it obtains control of Entity Y. Because of this change in

measurement basis, the measurement of Entity X’s initial interest (an asset) would

either decrease (if the fair value at the date of the step acquisition transaction is higher

than the original consideration paid for the initial interest) or increase (if the fair value

at the date of the step acquisition transaction is less than the original consideration

paid for the initial interest)8.

61. Paragraph 35 of IAS 8 states that a change in measurement basis is a change in

accounting policy. However, this change results from an event (ie obtaining control)

and does not result from the entity changing the measurement basis of its investment

in the absence of a transaction, other event or condition. Paragraph 16(a) of IAS 8

states that the application of an accounting policy for transactions, other events or

conditions that differ in substance from those previously occurring is not a change in

accounting policy. Accordingly, an entity does not apply the requirements in IAS 8

for changes in accounting policies in accounting for this difference.

62. We did not find requirements for similar or related transactions in which an entity

uses the accumulated cost approach. Accordingly, we considered whether this

difference meets the definition of income or expenses in the Conceptual Framework.

Definitions in the Conceptual Framework

63. Paragraphs 4.68 and 4.69 of the 2018 Conceptual Framework set out the following

definitions for income and expenses:

8 If the measurement of Entity X’s initial interest increases because the fair value of the initial interest on the date of obtaining control is lower than its original cost, then we think the entity also would need to consider whether its investment in the subsidiary is impaired applying IAS 36 Impairment of Assets.

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Income is increases in assets, or decreases in liabilities, that

result in increases in equity, other than those relating to

contributions from holders of equity claims.

Expenses are decreases in assets, or increases in liabilities,

that result in decreases in equity, other than those relating to

distributions to holders of equity claims.

64. In the light of the definitions above, we think the difference as described in

paragraphs 59–60 of this paper meets the definition of income or expenses. This is

because:

(a) the difference represents an increase or decrease in an asset (initial interest);

and

(b) does not result from a contribution from, or distribution to, holders of

equity claims. 9

How does an entity present this difference?

65. Paragraph 88 of IAS 1 states:

An entity shall recognise all items of income and expense in a

period in profit or loss unless an IFRS requires or permits

otherwise.

66. No IFRS Standard requires or permits the presentation of any difference between the

cost of an investment retained and its fair value other than in profit or loss.

Accordingly, applying paragraph 88 of IAS 1, we think the entity recognises this

difference as income or expense in profit or loss.

9 We think the difference also meets the definition of income or expenses in the 2010 Conceptual Framework. This is because paragraph BC4.95 of the 2018 Conceptual Framework explains that the Board noted that no major problems had been identified with the definitions of income and expenses. Hence, the only changes made were those necessary to make the definitions of income and expenses consistent with the revised definitions of an asset and a liability. In addition, other IFRS Standards require an entity to present differences resulting from a change in measurement basis in profit or loss. For example, see transactions discussed in paragraphs 26–27 of agenda paper 6A prepared for this meeting. In both those transactions, any difference resulting from a change in the measurement basis of the asset is recognised as income or expense. There is no indication that these requirements result in a departure from the definitions in the 2010 Conceptual Framework.

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67. We do not see a basis for recognising the difference directly in equity. Paragraph 109

of IAS 1 states (emphasis added):

Changes in an entity's equity between the beginning and the

end of the reporting period reflect the increase or decrease in its

net assets during the period. Except for changes resulting from

transactions with owners in their capacity as owners (such as

equity contributions, reacquisitions of the entity's own equity

instruments and dividends) and transaction costs directly

related to such transactions, the overall change in equity during

a period represents the total amount of income and expense,

including gains and losses, generated by the entity's activities

during that period.

Because the difference does not result from a transaction with owners in their capacity

as owners, we do not see a basis to present the difference directly in equity.

68. In our view, the entity recognises any difference between the fair value of the initial

interest and its original cost as income or expense in profit or loss, regardless of

whether, before the step acquisition transaction, the entity had presented subsequent

changes in fair value of its initial interest in profit or loss or OCI . The election in

paragraph 4.1.4 of IFRS 9 to present changes in OCI applies only to ‘subsequent

changes in fair value’. This difference does not arise from a change in the fair value

of the instrument––the entity ceases to apply IFRS 9 and immediately applies IAS 28

so no fair value change has occurred. Accordingly, the entity presents the difference

in profit or loss.

Question 2 for the Committee

Does the Committee agree with our analysis in paragraphs 57–68 of this paper

that, applying the accumulated cost approach, Entity X recognises as income or

expense, and presents in profit or loss, any difference between the fair value of

the initial interest at the date of obtaining control of the investee and its original

cost?

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Should the Committee add this matter to its standard-setting agenda?

Is the matter widespread and expected to have a material effect on those

affected?10

69. As stated in paragraphs 16–18 of this paper, the step acquisition transaction is not

common in several jurisdictions, particularly jurisdictions in which entities are either

not required to prepare separate financial statements or do not apply IFRS Standards

to separate financial statements. However, the transaction does occur more than

infrequently in some jurisdictions.

70. Our outreach findings (paragraph 19 of this paper) indicate that entities apply

different approaches in determining the cost of an investment in a subsidiary acquired

in stages (Question A). Because the transaction does not occur frequently, we do not

have evidence to assess whether the different approaches have a material effect on

those affected.

71. IAS 27 does not have particular disclosure requirements in respect of this transaction.

However, paragraph 15 of IAS 27 requires an entity to apply all applicable

IFRS Standards when providing disclosures in its separate financial statements.

Accordingly, when the application of either the FV as deemed cost approach or the

accumulated cost approach would have a material effect on the separate financial

statements, we would expect an entity to apply paragraph 122 of IAS 1 and disclose

the judgement it has made in applying its accounting policy. Paragraph 122 of IAS 1

states:

An entity shall disclose, along with its significant accounting

policies or other notes, the judgements, apart from those

involving estimations (see paragraph 125), that management

has made in the process of applying the entity’s accounting

policies and that have the most significant effect on the amounts

recognised in the financial statements.

10 Paragraph 5.16(a) of the Due Process Handbook.

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Is it necessary to add to or change IFRS Standards to improve financial

reporting?

72. We think for Question A (ie how an entity determines the cost of its investment in a

subsidiary acquired in stages), without additional requirements or explanation beyond

those in IAS 27 we cannot conclude that our view of determining the cost of an

investment in a subsidiary (ie FV as deemed cost approach) is the only way that

stakeholders might reasonably read the requirements. Accordingly, we would

conclude that it is necessary to change IFRS Standards if the Board or Committee

decides to address this matter.

73. Question B applies only if an entity uses the accumulated cost approach in

determining the cost of its investment in a step acquisition transaction. In this

situation, we think IFRS Standards provide an adequate basis for an entity to

determine its accounting for any difference between the fair value of the initial

interest at the date of obtaining control and its original cost. Accordingly, we think it

is not necessary to change IFRS Standards to address this matter.

Would any solution developed be effective for a reasonable period of time?11

74. The Board does not have a project on separate financial statements on its work plan or

in its research pipeline. Therefore, we think any solution developed by the Committee

to address Question A would be effective for a reasonable period of time.

Can the matter be resolved efficiently (is it sufficiently narrow in scope)?12

75. The Board could undertake standard-setting to specify whether an entity applies the

FV as deemed cost approach or the accumulated cost approach when determining the

cost of an investment in a subsidiary acquired in stages (Question A). However, as

discussed in paragraphs 48–49 of this paper, a similar question arises when

determining the cost of an investment in an associate or joint venture acquired in

stages.

11 Paragraph 5.21 of the Due Process Handbook. 12 Paragraphs 5.16(c) and 5.17 of the Due Process Handbook.

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76. Accordingly, we think it would be difficult to limit the scope of any possible standard-

setting only to IAS 27. In particular, we think there would be cross-cutting

implications for IAS 28 that the Committee would also need to consider.

77. There is also a question of whether the benefits would be sufficient to justify the cost

of adding a standard-setting project in this respect. Because the step acquisition

transaction occurs more than infrequently only in some jurisdictions (see paragraphs

16–18 of this paper), we think the benefits of any possible standard-setting in IAS 27

are limited. Step acquisition transactions are generally one-off transactions and,

applying the requirements in IFRS Standards we would expect an entity to provide

sufficient disclosures when the effect of any such transaction on an entity’s separate

financial statements is material. Further, as outlined in paragraph 70 of this paper, we

do not have evidence to assess whether the different approaches to determining cost

have a material effect on those affected.

78. We consider that there could be additional benefits if the scope of any standard-setting

project were also to consider the requirements in IAS 28. Those requirements apply

in both consolidated and separate financial statements. Accordingly, any standard-

setting would affect a broader population of transactions.

79. Nonetheless, the Board has a project on the equity method (Equity Method project) in

the research pipeline. As noted in the February 2018 IASB® Update, the Board

expects to start work on this project in 2019 or early 2020.

80. The submission asked particularly about the application of cost in the context of

separate financial statements and not in the context of IAS 28. In the absence of any

new information suggesting that work on this aspect of IAS 28 is more urgent than

other aspects of the equity method, we do not see a particular reason to reconsider this

aspect of IAS 28 in isolation at this stage. The Board could consider adding this

matter to the topics to be considered as part of the Equity Method project, including

considering any effect on separate financial statements.

Staff conclusion, having considered the Committee’s agenda criteria

81. We think the benefits of developing a narrow-scope amendment to IAS 27 to address

how to determine the cost of an investment in a subsidiary acquired in stages would

not outweigh the cost of doing so. We also think this could not be addressed without

https://www.ifrs.org/news-and-events/updates/iasb-updates/february-2018/

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also considering the requirements in IAS 28. Although we think it is possible to

develop a narrow-scope amendment to both IAS 27 and IAS 28 to address how an

entity determines cost for an investment acquired in stages, we have not obtained

information to suggest that the Board should reconsider this aspect of IAS 28 at this

stage, in isolation of its wider consideration of IAS 28 as part of the Equity Method

project. On balance, we think the Committee should not undertake standard-setting to

address this matter.

82. In situations in which an entity applies the accumulated cost approach to determine its

investment in a subsidiary, we think IFRS Standards provide an adequate basis for an

entity to determine its accounting for any difference between the fair value of the

initial interest on the date of obtaining control and its original cost (ie Question B of

this paper).

Staff recommendation

83. On the basis of our assessment of the Committee’s agenda criteria in paragraphs 5.16-

5.17 of the Due Process Handbook, on balance we recommend that the Committee

not add the matter to its standard-setting agenda. Instead, we recommend publishing

an agenda decision that explains the requirements that an entity applies when

accounting for the step acquisition transaction.

84. Appendix A to this paper outlines the proposed wording of the tentative agenda

decision.

Questions 3 and 4 for the Committee

3. Does the Committee agree with our recommendation not to add this

matter to its standard-setting agenda?

4. Does the Committee have any comments on the proposed wording of the

tentative agenda decision set out in Appendix A to this paper?

http://www.ifrs.org/DPOC/Due-Process-Handbook/Documents/Due-Process-Handbook-June-2016.pdf

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Appendix A—Proposed wording of the tentative agenda decision

The Committee received a request about how an entity applies the requirements in

IAS 27 Separate Financial Statements to a fact pattern involving an investment in a

subsidiary.

In the fact pattern described in the request, the entity preparing separate financial

statements:

- elects to account for its investments in subsidiaries at cost applying paragraph 10

of IAS 27.

- holds an initial investment in another entity (investee). The investment is an

investment in an equity instrument as defined in paragraph 11 of IAS 32 Financial

Instruments: Presentation. The investee is not an associate, joint venture or

subsidiary of the entity and, accordingly, the entity applies IFRS 9 Financial

Instruments in accounting for its initial investment (initial interest).

- subsequently acquires an additional interest in the investee (additional interest),

which results in the entity obtaining control of the investee––ie the investee

becomes a subsidiary of the entity.

The request asked:

(a) whether the entity determines the cost of its investment in the subsidiary as the

sum of:

(i) the fair value of the initial interest at the date of obtaining control of the

subsidiary, plus any consideration paid for the additional interest (fair value as

deemed cost approach), or

(ii) the consideration paid for the initial interest (original consideration), plus any

consideration paid for the additional interest (accumulated cost approach)

(Question A).

(b) how the entity accounts for any difference between the fair value of the initial

interest at the date of obtaining control of the subsidiary and its original consideration

when applying the accumulated cost approach? (Question B).

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Question A

IAS 27 does not define ‘cost’, nor does it explicitly specify how an entity determines

the cost of an investment acquired in stages. The Committee noted that cost is

defined in other IFRS Standards (for example, paragraph 6 of IAS 16 Property Plant

and Equipment, paragraph 8 of IAS 38 Intangible Assets and paragraph 5 of IAS 40

Investment Property). The Committee observed that the two approaches outlined in

the request arise from different views of whether the step acquisition transaction

involves (i) the entity exchanging its initial interest (plus consideration paid for the

additional interest) for a controlling interest in the investee, or (ii) purchasing the

additional interest while retaining the initial interest.

Based on its analysis, the Committee concluded that a reasonable reading of

requirements in IFRS Standards could result in the application of either one of the two

approaches outlined in this agenda decision (ie fair value as deemed cost approach or

accumulated cost approach). The Committee observed that an entity would apply its

reading of the requirements consistently to all step acquisition transactions. An entity

would also disclose the selected approach applying paragraphs 117–124 of IAS 1

Presentation of Financial Statements if that disclosure would assist users of financial

statements in understanding how step acquisition transactions are reflected in

reporting financial performance and financial position.

Question B

IFRS Standards do not explicitly specify how an entity applying the accumulated cost

approach accounts for any difference between the fair value of the initial interest at

the date of obtaining control of the subsidiary and its original consideration. In these

circumstances, the entity applies the requirements in paragraphs 10-11 of IAS 8

Accounting Policies, Changes in Accounting Estimates and Errors. The Committee

observed that such a difference meets the definitions of either income or expenses in

the Conceptual Framework for Financial Reporting. Applying paragraph 88 of

IAS 1, the Committee concluded that the entity recognises this difference as income

or expense in profit or loss—this is regardless of whether, before obtaining control,

the entity had presented subsequent changes in fair value of the initial interest in profit

or loss or OCI.

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For Question A, the Committee considered whether to develop a narrow-scope

amendment to address how an entity determines the cost of an investment acquired in

stages. The Committee observed that:

(i) it did not have evidence to assess whether the application of the two acceptable

approaches to determining cost, outlined in this [tentative] agenda decision, would

have a material effect on those affected; and

(ii) the matter could not be resolved without also considering the requirements in

paragraph 10 of IAS 28 to initially measure an investment in an associate or joint

venture at cost. The Committee has not obtained information to suggest that the

Board should reconsider this aspect of IAS 28 at this stage, in isolation of its wider

consideration of IAS 28 as part of its research project on the equity method.

On balance, the Committee [decided] not to undertake standard-setting to address this

matter.

For Question B, the Committee concluded that the principles and requirements in

IFRS Standards provide an adequate basis for an entity to determine its accounting.

Consequently, the Committee [decided] not to add the matter to its standard-setting

agenda.

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Appendix B—Submission

We have reproduced the submission below, and in doing so deleted details that would

identify the submitter of this request.

Accounting treatments for step disposal or step acquisition of interests in a

subsidiary in the separate financial statements of a parent

For ease of reference, we provide simplified illustrative examples as follows.

…

[…] Accounting treatment for obtaining control of S Co. by step acquisition of

interests in a subsidiary in the separate financial statements

Background information

• P Co. accounts for its investments in subsidiaries at cost in its separate financial

statements (Paragraph 10 in IAS 27)

• (Dec. 31. 20X0) P Co. acquires a shareholding of 10% in S Co. at 100 and P Co.

presents subsequent changes in fair value amounting to 20 in OCI (FV-OCI

election, Paragraph 5.7.5 in IFRS 9)

Statement of Financial Position (Dec. 31. 20X0) FV-OCI equity instrument 120 .... OCI 20

• (Jan. 31, 20X1) P Co. acquires additional interests of 45% in S Co. at 540 and

obtains control of S Co.

• Assume that no impairment has occurred

Issues

7. If P Co. has been accounting for its investments in subsidiaries at cost in its

separate financial statements (Paragraph 10 in IAS 27), how should its

investments in S Co. be accounted for at the acquisition date (the date of obtaining

control)?

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Views

View 1-1: the carrying amount at the acquisition date is 660 (120 + 540) which

is the sum of the carrying amount of retained interests and consideration

transferred to acquire additional interests at the acquisition date. The gain

recognised in OCI before obtaining control (20) can be immediately transferred

within equity at the acquisition date.

8. Referring to paragraph 42 of IFRS 3, the interests in the subsidiary could be

considered to be acquired in one lump at the acquisition date, the carrying amount

should be the fair value at the acquisition date including the previously held 10%

interests.

9. According to paragraph BCE.3813 in IFRS 9; P Co. can transfer the

cumulative gain or loss within equity at the acquisition date.

View 1-2: The carrying amount at the acquisition date is 660 (120 + 540) which

is the sum of the carrying amount of retained interests and consideration

transferred to acquire additional interests at the acquisition date. The gain

previously recognised in OCI before obtaining control (20) cannot be

immediately transferred within equity at the acquisition date.

View 2: Irrespective of the accounting treatment under IFRS 9 after the initial

acquisition of the existing interests (10%), P Co. shall go back to the historical

cost14 (100) and cancel the gain previously recognized in OCI (20). Hence, the

carrying amount at the acquisition date is 640 (100+540).

10. P Co. acquired interests in S Co. in two steps. As IAS 28 does not explicitly

require or allow to apply deemed cost, the cost (640) of the interests in the

subsidiary (S Co.) is the sum of the historical cost of the existing interests in S Co.

13 BCE.38 Although IFRS 9 prohibits recycling of gains and losses into profit or loss when an equity investment is derecognised, entities are able to transfer the cumulative gain or loss within equity at any time; for example, to provide information on realisation. (the rest omitted) 14 Historical cost: Assets are recorded at the amount of cash or cash equivalents paid or the fair value of the consideration given to acquire them at the time of their acquisition.

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(100, 10%) and the additional interests in S Co. (540, 45%). Accordingly, the gain

previously recognised in OCI (20) shall be cancelled15 .

11. Also, according to the notion of historical cost in the Conceptual Framework

for Financial Reporting, the carrying amount at the acquisition date under cost

method is the sum of the initial historical cost of the existing interests in S Co. and

the additionally acquired interests in S Co. at the acquisition date.

Additional issues

12. If accounting policy for the previously held investment (10%) was to measure

it at FVPL, what will be the appropriate treatment for the previously held interest

at the acquisition date? Historical cost (100) or fair value at the acquisition date

(as deemed cost)? If historical cost is applied to the original investment (10%), in

which will the changes in fair value relating to the previously held investment (20)

be reflected? Retained earnings or profit or loss in 20X1?

Reasons for the IFRS IC to address the issue

(a) Is the issue widespread and has, or is expected to have, a material effect on

those affected?

Yes. As there is no specific guidance on the issue addressed in this paper under

IAS 27 and IFRS 9, different views exist on the accounting treatments for step

disposal or step acquisition of interests in a subsidiary. Major accounting firms

also seem to hold different views on this issue – please refer to the below details

pertaining to the Big 4 global manual, in the alphabetical order.

i. Deloitte, iGAAP 2017 […].

ii. EY, International GAAP 2016 […].

iii. KPMG, 13th Edition 2016/17, Insights into IFRS, […].

(b) Would financial reporting be improved through the elimination, or reduction,

of diverse reporting methods?

15 (DR) OCI 20 (CR) FV-OCI equity instrument 20

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Yes. Consistent application of IFRS Standards on the issue would enhance

comparability of financial statements across entities.

(c) Can the issue be resolved efficiently within the confines of IFRSs and the

Conceptual Framework for Financial Reporting?

Yes. It can be resolved efficiently as the issue is related to the interpretation of

paragraph 10 of IAS 27 when applying IFRS 9.

(d) Is the issue sufficiently narrow in scope that the Interpretations Committee

can address this issue in an efficient manner, but not so narrow that it is not cost-

effective for the Interpretations Committee to undertake the due process?

Yes. We specified the issue to be the accounting treatments for partial disposal or

partial acquisition of interests in a subsidiary.

(e) Will the solution developed by the Interpretations Committee be effective for a

reasonable time period?

Yes. The issue does not relate to any of current or planned IASB projects.

For these reasons, we believe that this issue meets the criteria for acceptance onto

the Committee’s agenda.

AP6B: Step acquisition - IFRS Foundation

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